IR35: what global teams should know

IR35 is UK tax legislation that affects how contractors are taxed when they work through an intermediary like a limited company. If you're a global company working with UK contractors, or a contractor working with UK clients, IR35 determines whether the contractor pays tax as a business or as an employee.

The rules changed significantly in 2021 when the off-payroll working rules extended to the private sector. Now, medium and large companies are responsible for determining IR35 status and handling tax obligations. Get it wrong, and you face back taxes, penalties, and interest.

This guide provides a practical overview of IR35 for global teams. It's informational, not legal or tax advice. When making IR35 determinations, consult qualified UK tax advisors or employment counsel familiar with your specific situation.

What IR35 is and why it exists

IR35 (officially called the "Intermediaries Legislation") was introduced in 2000 to prevent tax avoidance. The concern was that workers were setting up limited companies to provide services, paying themselves through dividends and low salaries to minimize income tax and National Insurance contributions, even though they were effectively employees.

The legislation asks: if the intermediary (the contractor's limited company) didn't exist, would this person be an employee? If yes, they're "inside IR35" and must pay tax as if they were employed. If no, they're "outside IR35" and can operate as a genuine business.

Originally, contractors were responsible for determining their own IR35 status. But in 2017 (public sector) and 2021 (private sector), the rules shifted. Now, the client organization is responsible for making the determination for medium and large companies. This is called the "off-payroll working rules."

The three key tests

IR35 status is determined by examining the actual working relationship, not just the contract terms. Courts and HMRC look at three main factors:

1. Substitution: Can the contractor send someone else to do the work? A genuine business can substitute workers. An employee cannot. If the client requires the specific individual and won't accept a substitute, this suggests employment. If the contractor has an unfettered right to send a substitute (and would actually do so if needed), this suggests self-employment.

2. Control: Who controls what work is done, how it's done, when it's done, and where it's done? Employees are controlled by their employer. Contractors control their own work. If the client dictates working hours, location, methods, and processes, this suggests employment. If the contractor decides how to deliver the agreed outcomes, this suggests self-employment.

3. Mutuality of obligation (MOO): Is there an ongoing obligation for the client to provide work and the contractor to accept it? Employees have MOO—the employer must provide work and pay, the employee must be available and accept assignments. Contractors work on a project basis with no ongoing obligation. If the relationship is continuous and indefinite, this suggests employment.

Beyond these three core tests, HMRC considers other factors: whether the contractor provides their own equipment, whether they bear financial risk, whether they can profit from sound management, whether they work for multiple clients, and whether they're part and parcel of the client's organization.

Who's responsible for IR35 status

Responsibility for determining IR35 status depends on the size of the client organization and whether it's public or private sector:

Small companies: If the client is a small company (fewer than 50 employees, turnover under £10.2M, balance sheet under £5.1M), the contractor's personal service company is responsible for determining status and paying any tax due.

Medium and large private sector: The client is responsible for determining status and issuing a Status Determination Statement (SDS). If the contractor is inside IR35, the fee-payer (usually the client or agency) must deduct tax and National Insurance and pay it to HMRC.

Public sector: The client is always responsible, regardless of size. The same rules apply as for medium and large private sector companies.

If you're a global company working with UK contractors, you need to determine whether you're a small company under UK rules. If not, you're responsible for making IR35 determinations and handling tax obligations for contractors deemed inside IR35.

Status Determination Statement (SDS)

If you're responsible for determining IR35 status, you must provide the contractor with a Status Determination Statement before the contract starts (or within 45 days of the rules applying to you). The SDS must explain your decision and the reasons for it.

The contractor can challenge your determination if they disagree. You must respond within 45 days, explaining whether you're maintaining or changing your decision. If you don't respond, you become liable for any tax due, even if the contractor was actually inside IR35.

HMRC provides an online Check Employment Status for Tax (CEST) tool to help make determinations. While not legally binding, HMRC says it will stand by CEST results if you provide accurate information. However, CEST has limitations and doesn't cover all scenarios, so many companies also seek professional advice.

Inside vs outside IR35

If a contractor is determined to be inside IR35, they're treated as an employee for tax purposes (but without employee benefits). The fee-payer must deduct income tax and National Insurance contributions before paying the contractor's company. The contractor receives less money but doesn't get holiday pay, sick pay, pension contributions, or other employee benefits.

If a contractor is outside IR35, they operate as a genuine business. They invoice the client, receive full payment, and handle their own tax affairs. They can pay themselves through a combination of salary and dividends, potentially reducing their tax burden. They have more flexibility but also more responsibility.

Many contractors prefer to work outside IR35 because it's more tax-efficient and preserves their business autonomy. Many clients prefer contractors to be outside IR35 to avoid the administrative burden of operating PAYE (Pay As You Earn) for contractors.

Practical steps to stay outside IR35

If you want to engage contractors outside IR35, structure the relationship to demonstrate genuine self-employment:

Substitution: Include a genuine right of substitution in the contract. The contractor should be able to send a qualified substitute without needing your approval (though they may need to notify you). Document that this right is real, not just theoretical.

Control: Define outcomes and deliverables, not methods and processes. Let the contractor decide how to achieve the results. Don't require specific working hours or locations unless necessary for the work. Don't integrate the contractor into your team structure or management hierarchy.

Mutuality of obligation: Work on a project basis with defined start and end dates. Don't create an expectation of ongoing work. Don't require the contractor to be available for future assignments. Make it clear that each project is a separate engagement.

Other factors: Pay on a project or milestone basis, not hourly or monthly. Let the contractor use their own equipment. Don't provide employee benefits. Don't include the contractor in company communications or org charts. Ensure the contractor works for multiple clients.

But remember: the actual working relationship matters more than the contract terms. If you treat the contractor like an employee in practice, IR35 will likely apply regardless of what the contract says.

Documentation and record-keeping

Maintain thorough documentation of your IR35 determinations and the working relationship. Keep copies of the contract, the Status Determination Statement, any challenges and responses, and evidence supporting your determination (CEST results, professional advice, working practices).

Document how the contractor actually works: Do they set their own hours? Do they work from their own location? Do they use their own equipment? Do they work for other clients? Do they have substitution rights? This evidence is crucial if HMRC challenges your determination.

Keep records of invoices showing the contractor's business name and details. Maintain evidence of the contractor's business operations (website, business insurance, other clients, business bank account). Store all records for at least six years, as HMRC can investigate historical engagements.

Penalties and enforcement

If HMRC determines that a contractor should have been inside IR35 but was treated as outside, the responsible party (client or fee-payer) must pay the tax and National Insurance that should have been deducted, plus interest and potentially penalties.

Penalties can be significant. If HMRC believes you were careless, penalties can be up to 30% of the tax due. If they believe you were deliberately non-compliant, penalties can reach 100% of the tax due. Interest accrues from when the tax should have been paid.

HMRC has been actively investigating IR35 compliance since the 2021 rule changes. They target companies with many contractors, particularly in IT, consulting, and professional services. Taking reasonable care in making determinations and keeping good records is essential.

IR35 and global teams

If you're a non-UK company working with UK contractors, IR35 still applies if the contractor is working in the UK or the work is performed for a UK client. You need to determine whether you're a small company under UK rules (which is unlikely for most global companies) and make IR35 determinations accordingly.

Many global companies find IR35 compliance burdensome and prefer to work with contractors outside IR35 or use an EOR for UK workers who would be inside IR35. Some avoid UK contractors entirely due to the complexity and risk.

If you're working with UK contractors, factor IR35 into your contractor management processes. Make determinations carefully, document thoroughly, and consider professional advice for complex cases. The cost of compliance is far less than the cost of getting it wrong.

The bottom line

IR35 is UK tax legislation that determines whether contractors pay tax as businesses or employees. Medium and large companies are responsible for making determinations and handling tax obligations. The three key tests are substitution, control, and mutuality of obligation.

To keep contractors outside IR35, structure relationships to demonstrate genuine self-employment: real substitution rights, minimal control, project-based work, and business-to-business operations. Document everything thoroughly and seek professional advice when needed.

If you're working with UK contractors outside IR35, contractor management software can help you maintain proper documentation, track project-based work, and keep audit trails—all while preserving the business-to-business nature of the relationship.